CHAPTER 8 MODALITIES FOR THE INTROD

CHAPTER 8 MODALITIES FOR THE INTRODUCTION OF ECONOMIC INSTRUMENTS
The selection of the relevant set of economic instruments for a particular developing country or a transitional economy at a given point in time is determined by the country's special conditions as discussed in the previous chapter. Yet this leaves a large set of instruments from which to choose. Criteria for specific instrument selection needs to be established, or if a set of instruments is selected, an assessment must proceed implementation. Furthermore, the adoption of an economic instrument approach to environmental policy and sustainable development and the specific instruments chosen would have institutional and human resource requirements and financial implications that need to be addressed. For example, certain instruments such as secure land titles require cadastral surveys;environmental bonds and self-assessed charges require environmental auditors; and revolving funds may require new institutions. The objective of this chapter is to detail the criteria for instrument valuation and selection and to assess the human, institutional, and financial requirements. Particular attention is paid to distributional considerations, dynamic efficiency, and political acceptability.
Assessment of Instruments
The assessment and selection of instruments is best done by asking and answering the following nine questions, all conditioned by the special circumstances of the particular country concerned: Environmental Effectiveness: Will the instrument achieve the environmental objective within the specified time span and what degree of certainty can be expected? If the environmental outcome is somewhat uncertain or experimental (trial and error) and different instrument levels are needed, how acceptable is deviation from the set goal? The answer depends to a large extent on the nature of environmental damage in question. The acceptable margin of error is much higher for reversible environmental damage, depletion of substitutable resources, or generation of biodegradable waste than for irreversible loss of unsubstitutable assets (e.g., biodiversity, species loss) and generation of hazardous waste.
Cost Effectiveness: Will the instrument achieve the environmental objective (or target) at the minimum possible cost to society? Not only are environmental budgets limited, but any savings can be used to achieve other social objectives (e.g., equity) or to pursue further environmental improvement. The costs to society of pursuing certain environmental objectives through a particular instrument or set of instruments is not limited to the cost of monitoring and enforcement by the environmental agency. The largest component of the social cost of environmental intervention is the cost of compliance by the industry (e.g., output reduction, capital and operating cost of abatement technology, and the additional cost of switching to higher-cost inputs, such as from coal to natural gas). A second component of the social cost is the distortionary effect of the particular instrument chosen. Most economic instruments if rightly chosen and set at the right level (e.g., Peguvian taxes set equal to the marginal damage cost) are corrective of existing distortions and hence have a negative distortion cost (i.e., a correction benefit). There are, however, economic instruments such as subsidies which, though statically equivalent to environmental taxes, dynamically (in the long-run) they encourage entry into the polluting industry, thereby increasing rather than reducing pollution and hence violating the environmental effectiveness criterion above.
Flexibility: Is the instrument flexible enough to adjust to changes in technology, the resource scarcity, and market conditions? For example, in the face of inflation will it maintain its potency or will it be gradually eroded into an ineffective instrument. Indexing to inflation is one way of maintaining the value of the instrument; another is by setting the instrument (e.g., a charge in terms of a percentage of the price, rather than at a fixed nominal monetary value). With regard to scarcity, the instrument's value or level must rise with increasing resource or environmental scarcity. For example, tradeable emission permits meet this criterion, as do property rights (their value rises with scarcity); command and control standards and environmental bonds do not adjust automatically to changing resource scarcities (they need to be deliberately adjusted). With regard to technology, will the instrument adjust to changes in monitoring, abatement and production technology or will it soon become obsolete by new technologies? For example, mandated best available technology, an extensively used command and control instrument, does not meet this criterion unless it is deliberately and regularly revised, at great cost.
Dynamic Efficiency: Does the instrument provide incentives for developing and adopting new environmentally cleaner and economically more efficient technologies? Does it promote development of an environmentally sound infrastructure and economic structure in general? Charges and tradeable permits, for example, meet this criterion while effluent standards or mandated technology do not. Perhaps more importantly for developing countries is the extent to which the instrument provides an incentive for environmentally sound and economically efficient structural change. A dynamically efficient instrument is one that encourages the flow of resources towards activities in which the country has a genuine comparative advantage (i.e., towards commodities that can be produced at a domestic resource cost, inclusive of the resource depletion cost and environmental cost, which is lower than the world price). The structural-change effects of the instrument are equally important with regard to infrastructure and urban development. For example, low gasoline prices in the United States
have resulted in a dispersed pattern of development and land use that make the development of most transit systems unprofitable and the economy dependent on private driving, with the ultimate consequence being that air quality standards are very costly and difficult to accomplish. In contrast, European cities' mass transit systems are profitable because of the high density land use induced by high gasoline prices.